Providing Robo-Advice To Retail Clients
What is robo-advice?It is claimed that around $US300 billion of funds under management on a worldwide basis, are under the management of so called...
Providing Robo-Advice To Retail Clients
What is robo-advice?
It is claimed that around $US300 billion of funds under management on a worldwide basis, are under the management of so called robo advisers, which are described (see source 1) as computers powered by algorithms that can assess investors’ risk profiles and investment objectives and make appropriate recommendations and even arrange trades of securities or interests in managed funds.
That $US300 billion is expected to reach $US2.2 trillion by 2020.
In Australian regulatory terms robo-advice can be general or personal advice and can be narrowly scoped or be a detailed plan.
New regulatory guidance
In late 2016 ASIC issued Regulatory Guide (RG) 255 (source 2) about robo-advice, though they refer to this form of advice as digital advice.
It is assumed in this article that financial service providers seeking to provide robo-advice will have appropriate licensing or authorisations. That said, the RG does set out, at RG 255.30, some instances where licensing is not required, for example the providers of some generic financial calculators have been exempted from licensing requirements.
Presumably though, most providers would seek to provide general advice only, to avoid the cumbersome process of issuing statements of advice (SOA).
The RG cites as an example of robo general advice, a smartphone app that recommends clients invest in a handful of model portfolios, constructed on the usual criteria.
Commentary on the stocks within the portfolios is also provided.
The app does not take into account a client’s relevant circumstances, and therefore personal advice is not being provided.
By contrast, an app or website may determine a client’s investment profile by asking a client a number of questions about their financial situation and objectives.
The app or website then recommends an investment strategy based on the provided information, and a SOA is provided. Personal advice has been provided.
Licensing and compliance with licence obligations
A robo-advice or fintech business seeking to become licensed, and stay licensed, will need to demonstrate certain things, in the nature of the following, in addition to the standard basics –
- That relevant staff understand the technology (including the algorithmic software) used in provision of the digital advice, and can review the robo-advice provided from time to time;
- That there are procedures in place to monitor and test algorithms; That there are proper arrangements in place to ensure that client information is stored and transmitted securely;
- That at least one responsible manager has the training and competency standards required of natural person advisers, even though no natural person has been directly involved in the advice; and
- That their cyber security is assessed from time to time against recognised security standards.
Source 1 makes the point that the guidance does not require a qualified third party to sign off on the “robustness” of algorithms and formulas on a regular basis, and that this is a weakness of the guidance.
That said, the guidance does require regular monitoring and testing of algorithms.
So, if this part of the financial advice industry really starts to thrive, look out for potential extension of the guidance!
Personal advice and compliance with the best interests duty
The usual obligations that apply to the provision of conventional and robo-advice are the same, and this applies to the scaling or limiting, of advice.
The Corporations Act clearly provides that personal advice can be provided through a computer program.
That means, as a result of application of the bests interests duty, applying to personal advice (only), that a robo adviser must provide appropriate advice, warn a client if advice is based on inaccurate information, and prioritise the client’s interests over its own.
In turn, this requires explanations through the advice process about the scope of the advice, the filtering out of clients for whom the advice might not be appropriate, information about upfront and ongoing costs, how the client can withdraw from the process, and why the client would be better off following the advice.
In particular, the filtering out process, or “triage” (as ASIC describes it) needs to be carefully constructed, otherwise the regulator’s attention is going to be attracted.
Importantly, the guidance requires that where algorithm errors are detected, with the prospect of client loss, immediate steps should be taken to rectify problems.
Then, there is the unwelcome prospect of having to consider whether there is a reportable (significant) breach notification to be made to the regulator, and, remediation of clients who have suffered loss as a result of the provision of defective advice.
Conclusion
It looks like robo advice is here to stay and will increase its reach. Providers of this form of advice – whether personal (and whether scoped or not) or general – need to be aware, as mentioned earlier, that the same rules that apply to face-to-face, conventional advice, apply to them, and where that is personal advice, that means observance of the best interests duty and provision of a SOA.
